How new rules have sharpened the ESG focus of pension schemes

From record rain­fall and flood­ing in New York to dev­as­tat­ing wild­fires in Turkey, the con­se­quences of inac­tion on cli­mate change are now impos­si­ble to ignore. For pen­sion schemes, a new reg­u­la­to­ry envi­ron­ment is on the hori­zon. 

From Octo­ber, a host of occu­pa­tion­al pen­sion schemes will have to start com­ply­ing with the Task Force on Cli­mate-Relat­ed Dis­clo­sures (TCFD) report­ing frame­work. This will see them com­mu­ni­cate with scheme mem­bers on how their pen­sions are exposed to cli­mate risk and how investee com­pa­nies are being held to account for reduc­ing their car­bon emis­sions.

While the TCFD frame­work ini­tial­ly most­ly applies to larg­er schemes — defined ben­e­fit schemes with more than £5bn of assets under man­age­ment — it also applies to pen­sion funds that are under a mas­ter trust arrange­ment. This affects a num­ber of defined con­tri­bu­tion (DC) schemes that are sig­nif­i­cant­ly small­er than £5bn, says Jen­nifer O’Neill, a respon­si­ble invest­ment con­sul­tant at Aon.

“There is a lot that needs to hap­pen to make those dis­clo­sures in terms of build­ing the report­ing struc­ture and the gov­er­nance that sits around it, deter­min­ing the strat­e­gy and look­ing at the risk man­age­ment effec­tive­ness, that all has to hap­pen before the pen­sion fund is in a posi­tion to dis­close,” O’Neill says. “That means for trustees and pen­sion scheme deci­sion-mak­ers, there is an awful lot of work involved which they need sup­port with.”

For small­er schemes that have few­er resources, meet­ing the new rules is like­ly to be a chal­lenge.

“The costs are quite oner­ous,” says Fran­cois Bark­er, a part­ner and head of pen­sions at law firm Ever­sheds Suther­land. “The big­ger schemes have got big­ger in-house resources and more bud­get for exter­nal advi­sors, so there is no doubt that the big­ger schemes and the big­ger providers are much bet­ter placed to do this.”

ESG pressure

While the TCFD require­ments are focused on report­ing rather than pre­scrib­ing how pen­sion schemes should invest their mem­bers’ sav­ings, Bark­er believes that as schemes are forced to dis­close more, it will like­ly influ­ence their invest­ment deci­sions as mem­ber scruti­ny grows.

“You’re already find­ing with some of the big­ger schemes that there are groups of mem­bers get­ting togeth­er and chal­leng­ing the pen­sion scheme for not doing enough about cli­mate change, so when they have to start pub­lish­ing this infor­ma­tion that will give much more ammu­ni­tion to those groups of mem­bers as well as third-par­ty indus­try groups that want to chal­lenge pen­sion funds to do more,” says Bark­er.

The increased focus on cli­mate risk and wider envi­ron­men­tal, social and gov­er­nance (ESG) con­sid­er­a­tions could also cre­ate addi­tion­al chal­lenges for pen­sion scheme trustees as they try to bal­ance grow­ing ESG com­mit­ments with their oth­er fidu­cia­ry duties.

“There is a slight risk that as you hone in on ESG and you devote all of this effort to ESG that you could poten­tial­ly drop the ball some­where else,” says Bark­er. “If your ESG pol­i­cy caus­es you to sell an asset that then hap­pens to out­per­form, you need to be able to jus­ti­fy what you’ve done in the round, rather than just because it was a good ESG deci­sion.”

Rita But­ler-Jones, co-head of defined con­tri­bu­tion sales at Legal & Gen­er­al Invest­ment Man­age­ment, says TCFD is ulti­mate­ly about gal­vanis­ing change across the entire invest­ment chain — from asset own­ers and asset man­agers to the investee com­pa­nies — by allo­cat­ing cap­i­tal to those who are doing most to reduce their car­bon foot­prints, as well as future-proof­ing pen­sion port­fo­lios and help­ing to build more resilient soci­eties. 

“There’s def­i­nite evi­dence that dis­clo­sure require­ments can speed up the deploy­ment of more green and few­er brown invest­ments,” she says. “Pen­sion schemes’ adap­ta­tion to cli­mate change is not an option — all pen­sion providers and schemes have a cru­cial role to play in get­ting Britain to net zero. Pen­sion providers and schemes that are shun­ning ESG risk incur­ring fines, legal chal­lenges, irrepara­ble rep­u­ta­tion dam­age and poten­tial invest­ment loss­es.”

But­ler-Jones says her firm has encour­aged com­pa­nies to strength­en the trans­paren­cy of their cli­mate impacts and their strate­gies to cut emis­sions, while sanc­tion­ing those com­pa­nies that fail to meet their tar­gets.

Social and governance focus

While the main focus so far has been on cli­mate-relat­ed invest­ing — the “E” in ESG —O’Neill says the social aspect is grow­ing in impor­tance. Indeed, socioe­co­nom­ic inequal­i­ty is the sec­ond-high­est issue on pen­sion fund investors’ minds, accord­ing to a recent Aon investor sur­vey. But­ler-Jones says there is also increas­ing focus on issues such as the gen­der pay gap and diver­si­ty at board­room lev­el.

“Cli­mate has been at the fore­front of peo­ples’ minds, but ‘S’ and ‘G’ is real­ly com­ing to life now in terms of how peo­ple view it and how impor­tant they are rat­ing it,” she says.

While the focus on reduc­ing car­bon emis­sions and ESG invest­ment in gen­er­al can ben­e­fit soci­ety at large, it also has the poten­tial to deliv­er bet­ter out­comes for UK pen­sion hold­ers.

“Mem­bers are why we’re here and that should be at the fore­front of our minds — bet­ter invest­ment deci­sion-mak­ing has a pos­i­tive effect on pen­sion out­comes for mem­bers, and that bet­ter deci­sion-mak­ing has to include respon­si­ble invest­ment,” says O’Neill.

The wider pub­lic dis­course and increased atten­tion on cli­mate change is also encour­ag­ing scheme mem­bers to take more of an inter­est in ESG mat­ters and by exten­sion, their over­all pen­sion plans.

“It has always been chal­leng­ing to engage mem­bers in their sav­ings, espe­cial­ly in the DC space, but what we’re find­ing is that ESG seems to be the mag­ic key that is help­ing peo­ple engage with their pen­sion and look at their pen­sion more broad­ly,” says But­ler-Jones. “It’s not just about ‘is my fund ESG’, it’s also about ‘am I sav­ing enough and will I have enough for retire­ment’, so it’s had a knock-on impact on engage­ment in the DC pen­sions world.”